An eerie calm descended briefly on Credit Suisse's Homebuilders Conference in New York yesterday, when its large audience of investment bankers and other financial cognoscenti broke away from scrolling through their Blackberries long enough to gape at two large screens projecting Bloomberg's live feed of the Federal Reserve Board's Open Market Committee decision on the federal fund rate. The committee's 50-basis-point rate cut, to 4.75 percent, was almost beside the point, though, as the audience that day listened to eight of the industry's largest public homebuilders and one extremely gloomy economist tell them that the housing slump would be hanging around for a quite a while longer.
Officials from Hovnanian Enterprises, Beazer Homes, The Ryland Group, Standard Pacific, TOUSA, Toll Brothers, D.R. Horton, and MDC Holdings sang from the same song book about market conditions, which took a turn for the worse in August - "the cruelest month," quipped Boyce Thompson, editorial director at Hanley Wood, BUILDER's parent company, which co-sponsored the conference. The builders all conveyed pretty much the same message, too, about what they needed to do: that despite tough times and the uncertainty about when they would end, their companies are making the hard financial and operational choices to pull them through to recovery.
There was some cause for optimism following Hovnanian's successful Deal of the Century - a national three-day promotion held over the previous weekend, offering generous incentives and low rates on mortgages - that generated 2,100 gross sales. Beazer and Standard Pacific are also conducting aggressive promotions - StanPac wittily calling its 10-day campaign "Mission Possible" - to break through what Ara Hovnanian, his company's CEO, sees as "a lot of hesitation" among buyers, which every single builder executive at the conference blamed on the media's relentless coverage of the subprime mortgage meltdown.
The press, though, isn't alone in its skepticism about a housing market limping towards a still-indiscernible recovery. Mark Zandi, chief economist for Moody's Economy.com, who was the conference's luncheon speaker, delivered a cold slap in the face to anyone who thinks that buyer demand is about to revive any time soon. Zandi says that a combination of negative forces - too much unsold inventory (about 950,000 new and existing units, by his calculations), the prospect that between $400 billion and $500 billion worth of mortgages will default this year and next, and the steady 25,000- to 30,000-per-month job losses in housing-related companies - suggest that recovery is a long way off. More ominously, the troubles in the housing market are rattling the confidence of other businesses that are now thinking twice about hiring, and of consumers whom the credit crunch is forcing to curtail their spending.
"There's every reason to believe this picture gets worse, and the risk of recession is very high," Zandi warned.
Some builders share this pessimism; "Things are not very good in the housing industry," said TOUSA's chief Antonio Mon, in classic understatement. And the mortgage mess continues to instigate cancellations, which are still in the 30 to 33 percent range for the conference speakers. But each builder envisions a more positive outcome for his or her company as the industry stumbles towards some new level of normalcy. Essentially, the builders agree that while this ranks as one of the worst downturns, it's not the death knell for the industry, and there's every reason to believe that business will eventually return. "This is a reasonably normal cyclical period for housing," said MDC's chief Larry Mizel, in soothing tones.
With some variations, the builders have remarkably similar survival strategies, which revolve around reducing debt and increasing cash flow. Horton, which through June had reduced its debt by $900 million this year, expects to report $1 billion in cash flow by the end of fiscal 2007; TOUSA expects to be cash-flow positive in the second half of this year. To achieve their goals, builders continue to slash their operating expenses. Beazer, for one, has cut $60 million in selling and general administrative costs this year and plans to cut another $50 million in fiscal 2008. Its CEO, Ian McCarthy, notes that his company is evaluating every community and division to see which is justifying its continued existence.
Builders assured their audience they are doing all they can to lessen their inventory overhangs. Bill Wheat, Horton's CFO, estimates that his company adds $150 million in cash flow for every 1,000 inventoried homes sold. Horton, like the other builders, is dramatically scaling back on its speculative home building, and has "put the brakes" on new starts, which through June were down 43 percent, said Stacy Dwyer, its executive vice president and treasurer. Ryland Group's finished spec homes were down 47 percent from the third quarter of 2006, and Standard Pacific had reduced the average number of spec homes in its communities to 9.6 units as of June 30, from 12.9 a year earlier, said StanPac's CEO Steve Scarborough.
All of the builders have made significant - and in some cases massive - reductions in their land assets, either by selling lots they own or abandoning land-options they control. They are also extracting price concessions from product suppliers and, in several cases, altering their house plans to use less building material. (Ryland, for example, lowered its materials costs by 11.1 percent between last November and this June, said its CFO Gordon Milne.)
Toll Brothers' CEO Bob Toll said he's not disposed yet to sell land in favorable markets his company has owned or controlled for years. "Our ground isn't fungible, and I don't want to get rid of a building site in Brooklyn or Princeton or San Francisco. We have land in Florida that I'm not going to give away, at least not as long as we're positive [in earnings]," he said. That being said, through October Toll had reduced its land position by 31 percent this year. The other builders also expect to reduce their land assets further over the next several months, the clearest indication that they don't expect any imminent resuscitation in buyer demand. Another indication: Some builders have lowered their credit facilities because they have less need to use borrowed money to purchase land. And none of the builders even hinted at possible future mergers or acquisitions.
That raises the question of whether the public builders are simply treading water while the downturn plays itself out. They all sounded confident about an eventual upswing in business, but there was very little discussion during the conference about how they are preparing their companies for this eventual bounce back, outside of generalities about being in the right markets and managing their balance sheets for growth. (Mizel, at least, talked about how is company has rededicated itself to improving its customers' satisfaction, without revealing too many details.) Toll notes that when the industry reverts to a seller's market again, buyers could find a paucity of product to choose from because "nothing right now is being put through the approvals grinder."
The builders seem convinced, in fact, that their companies will come out of this cycle stronger as long as they don't panic, keep a handle on expenses, and be ready financially to pounce. "There will be great opportunity for those of us who are still around and have enough money to play," said Toll.
Learn more about markets featured in this article: San Francisco, CA.
